Market report

Lots of leverage raising volatility of stock market

Wall Street boiled in its own juices Thursday, sending stock prices sharply lower but ending the day flat.

No one could say when this summer's wild swings, magnified by debt-financed trading by megabuck players, will be over.

"We're in for a period of instability," said Gary Brinson, a private investor in Chicago who manages his own family and endowment funds.

"You don't know the magnitude of the leveraged positions and the extent to which people will be forced to sell."

The Dow Jones industrial average closed down a mere 15.69 points, at 12,845.78. At midday the Dow was off 343 points, sinking nearly 1,500 points from its peak of 14,000 just a month ago.

The benchmark Standard & Poor's 500 index closed up 4.57, at 1411.27, after being off at midday more than 2.5 percent from Wednesday's close. Before the rebound, the S&P slumped to a 10 percent loss from its July 19 peak.

Early in the day, stocks sank in sympathy with sell-offs in Asian and European markets. Other investments, including commodities, lost ground as professional investors scrambled to raise cash.

But financial-services stocks led a powerful rally in the final hour, reflecting optimism that distressed firms, such as Bear Stearns, would receive fresh capital, and that cash injections by the world's central banks would prevent a crisis.

Bear Stearns shares jumped $13.29, or 13 percent, to $116.44. JPMorgan Chase was the biggest winner in the 30-stock Dow, closing up $2.47, at $45.47.

The stock market hasn't been this volatile since 2002, when the retreat from the technology stock bubble of the late 1990s ended. But this time, so-called leverage in financial markets is far greater, said Brinson.

Small declines in stocks and other investments compound into huge losses at hedge funds that purchased the investments with debt equal to as much as nine times cash invested, he said.

Investors pressed to raise cash to satisfy sudden collateral demands by lenders have been selling their most liquid investments, from crude oil futures to shares of technology giant Apple, one of the year's best-performing stocks.

"We don't have good historical precedent here for this amount of leverage and the opaqueness of who's got the leverage," Brinson said.

"It's hard for the average person to understand how relatively modest change in the value of an asset can have such huge effects on markets."

Jeremy Siegel, finance professor at the University of Pennsylvania and author of "Stocks for the Long Run," said the allure of secret hedge-fund strategies could wear thin as markets continue to roil.

"We've got all this money in hedge funds and alternative investments," he said, "and people are going to say: 'Just a minute, what am I doing? I want an asset where I can see it every day of the week and I can see the price that I can sell it at.'"

Even in Thursday's turmoil, some corners of the market saw daylight. Indexes of small-company stocks and large, dividend-paying stocks advanced more than 2 percent. Treasury securities rallied again.

But it's probably not time to start bargain-hunting, until homeowners face the next round of higher payments for adjustable-rate mortgages and hedge funds shrink their debt levels, said Brinson.

"You are going to have to be patient here to see what happens as we go through the next several weeks of mortgage resetting and hedge-fund positions being rebalanced," Brinson said. "It's going to be difficult to know where to step into it."